Financial Times Editorial Comment: Equity in taxation

Financial Times Editorial Comment: Equity in taxation
Copyright The Financial Times Limited 2007
Published: May 9 2007 03:00 | Last updated: May 9 2007 03:00


The principle of progressive taxation - that those who earn more should pay more in income tax - has been in retreat since the 1970s, when marginal tax rates rose so high that they were a disincentive to hard work and enterprise. But the notion that the well-off should pay a higher percentage of their income in tax than the less well-off remains both accepted and correct.

Small wonder that there is now a movement in the US Congress to correct the fact that many of the richest people - those who work in private equity partnerships and some kinds of hedge fund - pay lower tax in percentage terms than others because their wealth is accumulated in capital gains, rather than being counted as income.

The fact that fund managers in partnerships pay federal tax at a marginal rate of 15 per cent rather than 35 per cent distorts incentives. Private equity general partners gain this treatment on "carried interest" - their share of the rise in value of portfolio companies. This is further encouragement for executives to work for private funds rather than public companies.

The tax system should encourage entrepreneurship rather than employment. Many small businesses operate as partnerships and founders and owners ought to be able to count their long-term wealth creation as capital gain rather than annual income. But it is far less obvious that financial intermediaries should benefit from all of these economic privileges.

It is right, therefore, for politicians to examine the tax issue and to seek a way to even the playing field between public and private enterprise. It is also correct for authorities to examine closely the tax structure proposed by Blackstone, the private equity firm, for its initial public offering, which attempts to preserve these tax benefits for general partners.

There is a lot of devil in the detail, as Max Baucus, chairman of the Senate finance committee, has said. Eliminating capital gains treatment for every kind of partnership - from property to oil and gas - would be misguided and it would be difficult to establish a separate category for private equity. But that is not a principled argument for sticking to the status quo.

There is no need to rush into changing the tax code with the risk of broad and unintended consequences. It is better for Washington to understand the issue thoroughly and devise a suitable response. But there are already plenty of incentives for graduates to go into financial services rather than other industries. The lure of a tax break need not be another one.